Will This New Idea Replace Traditional Student Loans?

Imagine if companies treated people like investments rather than students. They would invest in individuals’ educations based on their grades, intended major, and career prospects. Rather than borrowing thousands of dollars in student loans, college students could get backed by an investment firm.

It may sound impossible, but it’s happening now. Purdue University made waves in the education community last year by announcing a new approach to paying for school: the income share agreement.

Offered as an alternative to student loans, the school created the “Back a Boiler” fund. They tapped into the power of investing partners and successful graduates to offset the cost for future students.

While income share agreements are not common, they are becoming increasingly popular as schools and families look for ways to minimize student loan debt. With the national student loan debt totaling over $1.3 trillion, out-of-the-box ideas are becoming hot topics.

What is an income share agreement?

In an income share agreement (ISA), the school deposits funds into an investment account run by an external company. The money is invested to yield returns that continue to grow to pay for students’ educations.

ISAs function like income-driven repayment plans, only they are offered through the school and the investment firm rather than the federal government.

Through the ISA, students agree to repay a set percentage of their income for a specific time period. Typically, it works out to 10 to 20 percent of the student’s discretionary income over the course of 10 years.

Unlike income-driven repayment plans, however, ISAs do not have set standards. This difference means that the repayment terms can vary depending on a student’s major or career path.

For example, a law student at a top-tier school might be considered a better investment than an English major at a less prestigious institution. Therefore, the law student could have access to more favorable repayment options.

Investment firms choose which students are the best risks and which are not. That may mean that some students are ineligible, and firms may eliminate entire schools.

Under an income share agreement, some graduates will end up paying their entire tuition amount back. However, in other cases, students will pay back much less than they would have paid if they had to foot the bill themselves. That change makes ISAs a great alternative to interest-heavy student loans.

When ISAs make sense

While ISAs might be a good idea for some people, they won’t work for everyone. ISAs make sense for a very particular set of students.

For students in need of additional money on top of federal loans, an ISA can be a valuable option. Particularly for people who are debt-averse and are wary of hefty interest rates, an ISA can be an appealing alternative to private student loans.

Finally, for students who do not qualify for federal aid, ISAs can be a way to pay for programs that normally do not qualify for federal loans, such as trade schools or community colleges.

However, ISAs are not practical for high-earners. Because their incomes determine their repayment terms — and unlike loans, can not be paid off early — they can end up paying substantially more than if they had used traditional loans.

What schools offer ISAs?

ISAs are big in South America but are still rarely used in the United States. However, there are some places where ISAs are available to students.

Oregon launched a pilot of the Pay It Forward model in 2013 and it continues in a very limited capacity. Under this plan, students attend college without paying for tuition and pay back a percentage of their incomes. The Pay It Forward program is currently under committee review and is expected to be sent to lawmakers in 2017.

In some cases, students can get an ISA by connecting with investment firms directly, rather than by going through the school. One of the biggest companies currently offerings ISAs is Cumulus Funding. They offer ISAs that cover as much as $10,000 of your education costs in return for a percentage of your income.

In the technology space, trade schools like App Academy use a similar model to teach students skills for a specific job. While the number of places offering ISAs is small now, the number is expected to grow, particularly as Purdue University expands its program.

The future of tuition

As tuition costs and student loan balances continue to skyrocket, schools will present more alternatives to student loans. An income share agreement is only one possibility.

Everything from scholarships to side-hustles can help minimize how much debt you need to take on. Evaluating your options before signing up for a loan is a smart way to limit your debt and your repayment terms.

If you’re in school and are ineligible for an ISA, or are a recent graduate struggling to manage your debt, you still have options, including:

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